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Mexican Energy Reform: The Necessity of Reform and How it Works

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Recent data from PEMEX (Petróleos Mexicanos), Mexico’s state-owned fossil fuels company, shows Mexico has the largest oil reserves in Latin America after Venezuela and Brazil (nearly 14 billion barrels). It also has shale-gas resources that might be as high as 460 trillion cubic feet, which would make it potentially the fourth largest holder of shale gas in the world.

However, according to Bloomberg New Energy in August, PEMEX’ oil output in July “was the lowest it has been in 18 years,” and PEMEX “is heading toward a ninth straight year of declining production.” Moreover, concerns exist that given PEMEX’ available extraction technology, its current reserves could only last nine years.

To combat these dire predictions yet take advantage of the potential for growth, energy reform legislation including constitutional amendments have been introduced by President Enrique Peña Nieto.

Under the current Mexican constitution, PEMEX is prohibited from entering into exploration and production contracts with private companies. Peña Nieto’s bill would change that provision. Although the reform would not allow “product-sharing contracts”, given that the state would remain the sole owner of all oil and gas reserves, it promotes “profit sharing contracts” with payment “by means of consideration payable in cash or in accordance with the resources found.”

PEMEX has also served as a cash cow for the Mexican government for some time. Recent estimates have put its annual tax burden in support of the government at US $67 billion. Therefore, Peña Nieto has also proposed a fiscal reform for PEMEX to reduce its tax burden and increase its ability to reinvest after-tax profits. It also consolidates its subsidiaries into two divisions: (a) exploration and production and (b) industrial transformation.

Additional changes by Peña Nieto would allow PEMEX to have more autonomy over its operations and grow. The liberalization of midstream and downstream sectors, such as the processing, refining, transport, storage, distribution and selling of hydrocarbons, petrochemicals and their derivatives would allow private companies to undertake these activities under the control of the state.

As a result of these reforms, Mexico would be expected to reach historic rates of exploration and production. Oil production would increase from 2.5 million barrels per day to 3 million by 2018 and 3.5 million or more by 2025. Natural gas production would also rise from 5,700 million cubic feet daily to 8,000 million by 2018 and 10,400 million by 2015.

Peña Nieto’s proposal is expected to pass within the next few months. If enacted, it will mark the largest private sector opening in decades and improve energy security for the nation. As the state’s monopoly dismantles, factors such as, the ability to meet demand, restructuring of prices, cost reduction, private investment and risk dispersion will increase profits, generate more jobs and level the playing field for Mexico with respect to its main energy competitors.